Full Report - Subregional Office for East and North-East Asia - escap

DEVELOPMENTAL MACROECONOMICS: THE CRITICAL ROLE OF PUBLIC EXPENDITURE CHAPTER 3
Box 3.2. (continued)
observed that “historically, all possible combinations have occurred: inflation with and without [economic] development, no
inflation with and without [economic] development” (p. 41 in his book).
Similar is the case for the relationship between public debt and macroeconomic instability. The mild positive relationship is driven
by outliers. In fact, there is no optimum debt-GDP ratio. A debt-to-GDP ratio of 60% is quite often noted as a prudential limit
for developed countries, which suggests that crossing this limit will threaten fiscal sustainability. For developing and emerging
economies, 40% is the suggested debt-to-GDP ratio that should not be breached on a long-term basis.
The 60% figure was one of a handful of targets that European Governments set at the start of the 1990s to prepare for economic
and monetary union and the eventual formation of the euro zone. There was no hint of optimality: this level was simply the
median debt-to-GDP ratio. Jonathan D. Ostry and others writing on “Fiscal space” in an IMF note (SPN/10/11, September 2010)
emphasized that the debt limit found in their research “is not an absolute and immutable barrier .... Nor should the limit be
interpreted as being the optimal level of public debt”. According to this IMF study by Ostry and others of 23 advanced countries,
the estimated debt limits, using the historical interest-rate-growth-rate differential, ranged from about 150% to 260% of GDP,
with the median being 192%. In the study it was assumed that interest-rate-growth-rate differentials were generally projected to
be less favourable than the historical experience. It was found that the corresponding median long-run debt ratio was 63% of
GDP and the median maximum debt ratio 183% of GDP.
In the 2012 IMF publication, entitled World Economic Outlook: Coping with High Debt and Sluggish Growth, it is clearly
acknowledged that debt thresholds are not robust: “(T)here is no simple relationship between debt and growth. In fact, our …
analysis emphasizes that there are many factors that matter for a country’s growth and debt performance. Moreover, there is
no single threshold for debt ratios that can delineate the ‘bad’ from the ‘good’.” (p. 109).
However, there should be some distinction between domestic and external debts. Countries should be more cautious about
external debts due to additional risk of exchange rate changes. In the IMF paper entitled “Assessing sustainability” (28 May
2002), it is noted that “...an external debt ratio of about 40 percent provides a useful benchmark” (p. 25). In interpreting this
benchmark, the authors of the report quickly added an important caveat: “… it bears emphasizing that a debt ratio above 40
percent of GDP by no means necessarily implies a crisis – indeed, … there is an 80 percent probability of not having a crisis
(even when the debt ratio exceeds 40 percent of GDP).”
The above discussion does not provide a reason for deliberately creating high inflation or high debt or deficit through irresponsible
macroeconomic policies. Instead, it highlights the need for achieving a balance between the stabilization and development roles
of macroeconomic policies. Monetary expansion to support productive investment may not cause inflation in the long-run,
and moderate inflation enhances fiscal space. The sustainability of a fiscal deficit itself depends on the productivity of public
expenditure. An explicit focus on the composition of public expenditure and their growth effects would enable both stabilization
and growth objectives to be addressed in more sustainable ways. Therefore, there should be a fuller consideration of the growth
effects of various kinds of government expenditure in designing fiscal policy.
143